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July

The AICPA’s Auditing Standards Board has published Statement on Auditing Standards No. 129, "Amendment to SAS No. 122 Section 920, Letters for Underwriters and Certain Other Requesting Parties, as Amended" (AICPA, Professional Standards, AU-C sec. 920). The AICPA issued the new guidance to address unintended changes in practice as a result of its clarity project.

The guidance amends or clarifies various requirements related to the responsibilities of auditors engaged to issue “comfort letters” to parties that have requested them related to nonissuer financial statements in a registration statement or other securities offerings.

SAS 129 is effective for comfort letters issued on or after December 15, 2014. The AICPA encourages early implementation.

At its July 23, 2014, meeting, the FASB discussed its project on financial statements of not-for-profit entities (NFPs). In addition, the FASB jointly discussed leases with the IASB.

Financial statements of not-for-profit entities

The FASB discussed (1) the relationship between this project and its research project on financial performance reporting and (2) presentation alternatives for capital-like transactions and events. The FASB tentatively decided:

To affirm its prior decisions to include certain types of cash in financing activities even though it is uncertain whether the cash flow statement will be addressed in the Board’s project on financial performance reporting. In addition, the FASB decided that “cash proceeds from the sale of long-lived assets should be classified as inflows from operating activities rather than as inflows from investing activities.”

To require an NFP to report a “transfer out of current operations for the amount of the gifted long-lived asset expected to be utilized in future periods. In subsequent periods, the NFP would report a transfer back into current operations to the extent long-lived assets are utilized during the current reporting period.”

To require the use of a placed-in-service approach to treat expirations of long-lived asset restrictions, which would remove the “option to release the donor-imposed restriction over an asset’s useful life.”

Leases

The FASB and IASB continued redeliberating revisions to lease accounting and discussed (1) sale-leaseback transactions and (2) lessor disclosure requirements.

The following table summarizes the boards’ tentative decisions related to sale-leaseback transactions:

Tentative decisions reached

FASB

IASB

The seller-lessee should apply the definition of a sale in the new revenue guidance (i.e., ASC 606 or IFRS 15) when determining whether the transfer of an underlying asset in the sale-leaseback qualifies as a sale.

X

X

The final leases standard should affirm that the existence of a leaseback would not prevent the seller-lessee from concluding that the underlying asset was sold.

X

X

A leaseback transaction that would result in a Type A lease would preclude sale accounting of the underlying asset by the seller-lessee.

X

The final standard would not include additional guidance on applying the revenue recognition standard’s control principle to sale-leaseback transactions.

X

If a transaction is based on “at-market” terms, any gain resulting from the sale in the transaction should be recognized immediately, which is consistent with the treatment for sales of nonfinancial assets that do not involve a leaseback.

X

The immediate recognition of gains from the sale would be limited to the portion associated with the residual asset.

X

A seller-lessee should recognize any loss resulting from the sale in a sale-leaseback transaction in a manner similar to losses resulting from the sale of other nonfinancial assets, and the buyer-lessor in the arrangement should account for the purchase of the asset in accordance with other existing accounting.

X

X

The leaseback in a sale-leaseback transaction should be accounted for in a manner consistent with other leases.

X

X

Both parties to the sale-leaseback transaction would determine whether an adjustment is required as a result of the off-market terms by assessing whether there is a difference between (1) the sales price and fair value of the asset sold or (2) the present value (PV) of the contractual lease payments and the PV of the lease payments at fair market value. The seller-lessee would account for any difference either as an adjustment to the ROU asset or additional financing from the buyer-lessor (i.e., separate from the lease liability). The buyer-lessor would recognize any difference as a prepayment of rent or additional financing to the seller-lessee (i.e., separate from the lease receivable).

X

X

A transaction that results in a failed sale should be accounted for as a financing arrangement.

X

The following table summarizes the boards’ tentative decisions related to lessor disclosure requirements:

Tentative decisions reached

FASB

IASB

Lessors should disclose certain quantitative and qualitative information about their practices for managing risks related to the residual value of its leased assets.

X

X

Lessors should apply the disclosure requirements in ASC 360 or IAS 16 for all assets that are subject to a Type B lease. In addition and should disclose by major class assets that are subject to a lease separately from those that are held and used by the lessor.

X

Lessors should apply the disclosure requirements in ASC 360 or IAS 16 for all assets that are subject to a Type B lease and should disclose as a class of property, plant, and equipment, assets that are subject to a lease separately from those that are held and used by the lessor.

X

Lessors must provide a maturity analysis of the future undiscounted cash flows that make up the Type A lease receivable balance. The amounts included in the maturity analysis should be reconciled to the balance sheet.

X

X

In addition, the boards tentatively decided to eliminate the lease receivables and residual asset reconciliation requirements from their May 2013 exposure draft; however, the FASB tentatively decided only to require additional disclosures about significant changes in the value of the residual assets during the period, while the IASB tentatively decided to require additional disclosures about significant changes in lessors’ net investment in leases.

At its July 23, 2014, meeting, the SEC adopted a final rule that will reduce the risk of runs in money market funds (MMFs) by requiring certain MMFs to use a floating net asset value (NAV) instead of a stable NAV. The final rule also contains new requirements related to redemption gates and liquidity fees.

The final rule was issued concurrently with a proposal from the Treasury Department and the IRS that (1) allows an MMF relief from tracking individual sales when complying with “wash sale” rules and (2) simplifies the basis for calculating gains and losses.

In addition, the SEC issued proposed and reproposed rules related to (1) MMF communications to investors and (2) the replacement of credit rating references in Rule 2a-7 and Form N-MFP with other factors a fund would use to assess liquidity and credit worthiness of investments to comply with Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The IASB has published the final version of IFRS 9, "Financial Instruments," bringing together the classification and measurement, impairment, and hedge accounting phases of the IASB's project to replace IAS 39, "Financial Instruments: Recognition and Measurement." This version adds a new expected loss impairment model and limited amendments to classification and measurement for financial assets. The standard supersedes all previous versions of IFRS 9 and is effective for periods beginning on or after January 1, 2018.

Background

The IASB's project to replace IAS 39 has been on the Board's active agenda since 2008. The Board has undertaken the project in phases, first issuing IFRS 9 in 2009 with a new classification and measurement model for financial assets and then adding requirements related to financial liabilities and derecognition in 2010. The IASB amended IFRS 9 in 2013 to add new general hedge accounting requirements.

This final version of IFRS 9 adds a new expected loss impairment model and amends the classification and measurement model for financial assets by adding a new fair value through other comprehensive income (FVTOCI) category for certain debt instruments and additional guidance on how to apply the business model and contractual cash flow characteristics test.

Summary of key requirements

Expected loss impairment model

The impairment model in IFRS 9 is based on the concept of providing for expected losses at inception of a contract, except in the case of purchased or originated credit-impaired financial assets, for which expected credit losses are incorporated into the effective interest rate.

Scope

The impairment requirements of IFRS 9 apply to:

Financial assets measured at amortized cost.

Financial assets mandatorily measured at FVTOCI (see below).

Loan commitments when there is a present obligation to extend credit (except when these are measured at fair value through profit or loss (FVTPL).

Financial guarantee contracts to which IFRS 9 is applied (except those measured at FVTPL).

Lease receivables within the scope of IAS 17, Leases.

Contract assets within the scope of IFRS 15, Revenue From Contracts With Customers (i.e., rights to consideration after transfer of goods or services).

General approach

With the exception of purchased or originated credit-impaired financial assets (see below), expected credit losses are required to be measured through a loss allowance at an amount equal to either of the following:

The 12-month expected credit losses (expected credit losses that result from those default events on the financial instrument that are possible within 12 months after the reporting date).

Full lifetime expected credit losses (expected credit losses that result from all possible default events over the life of the financial instrument).

A loss allowance for full lifetime expected credit losses is required for a financial instrument if the credit risk of that financial instrument has increased significantly since initial recognition. It is also required for contract assets or trade receivables that do not constitute a financing transaction in accordance with IFRS 15.

In addition, entities can elect an accounting policy to recognize full lifetime expected losses for all contract assets or all trade receivables that do constitute a financing transaction in accordance with IFRS 15. The same election is also separately permitted for lease receivables.

For all other financial instruments, expected credit losses are measured at an amount equal to the 12-month expected credit losses.

Significant increase in credit risk

With the exception of purchased or originated credit-impaired financial assets (see below), the loss allowance for financial instruments is measured at an amount equal to lifetime expected losses if the credit risk of a financial instrument has increased significantly since initial recognition, unless the credit risk of the financial instrument is low (e.g., investment grade) as of the reporting date, in which case it can be assumed that credit risk on the financial instrument has not increased significantly since initial recognition.

The assessment of whether there has been a significant increase in credit risk is based on an increase in the probability of the occurrence of a default since initial recognition.

The requirements also contain a rebuttable presumption that the credit risk has increased significantly when contractual payments are more than 30 days past due. In addition, IFRS 9 requires that (other than for purchased or originated credit impaired financial instruments) if a significant increase in credit risk that had taken place since initial recognition and has reversed by a subsequent reporting period (i.e., cumulatively credit risk is not significantly higher than at initial recognition), then the expected credit losses on the financial instrument revert to being measured based on an amount equal to the 12-month expected credit losses.

Purchased or originated credit-impaired financial assets

For purchased or originated credit-impaired financial assets, the asset is credit-impaired at initial recognition and therefore the estimated cash flows used to calculate the (credit-adjusted) effective interest rate at initial recognition incorporate lifetime expected credit losses. Subsequently, any changes in expected losses are recognized as a loss allowance with a corresponding gain or loss recognized in profit or loss.

Credit-impaired financial asset

Under IFRS 9, a "financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include[s] observable data about the following events:

(a) significant financial difficulty of the issuer or the borrower;

(b) a breach of contract, such as a default or past due event;

(c) the lender(s) of the borrower, for economic or contractual reasons relating to the borrower’s financial difficulty, having granted to the borrower a concession(s) that the lender(s) would not otherwise consider;

(d) it is becoming probable that the borrower will enter bankruptcy or other financial reorganisation;

(e) the disappearance of an active market for that financial asset because of financial difficulties; or

(f) the purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.”

Basis for estimating expected credit losses

Any measurement of expected credit losses under IFRS 9 should reflect an unbiased and probability-weighted amount that is determined by evaluating the range of possible outcomes as well as incorporating the time value of money. Also, the entity should consider reasonable and supportable information about past events, current conditions, and reasonable and supportable forecasts of future economic conditions when measuring expected credit losses.

To reflect time value, expected losses should be discounted to the reporting date by using the effective interest rate of the asset (or an approximation thereof) that was determined at initial recognition. A “credit-adjusted effective interest” rate should be used for expected credit losses of purchased or originated credit-impaired financial assets. In contrast to the “effective interest rate” (calculated by using expected cash flows that ignore expected credit losses), the credit-adjusted effective interest rate reflects expected credit losses of the financial asset.

Presentation

While interest revenue is always required to be presented as a separate line item, it is calculated differently according to the status of the asset with regard to credit impairment. In the case of a financial asset that is not a purchased or originated credit-impaired financial asset and for which there is no objective evidence of impairment as of the reporting date, interest revenue is calculated by applying the effective interest rate method to the gross carrying amount.

In the case of a financial asset that is not a purchased or originated credit-impaired financial asset but subsequently has become credit-impaired, interest revenue is calculated by applying the effective interest rate to the amortized cost balance, which comprises the gross carrying amount adjusted for any loss allowance.

In the case of purchased or originated credit-impaired financial assets, interest revenue is always recognized by applying the credit-adjusted effective interest rate to the amortized cost carrying amount.

Limited amendments to classification and measurement of financial assets

FVTOCI category

The final version of IFRS 9 introduces a new classification and measurement category of FVTOCI for debt instruments that meet the following two conditions:

Business model test — The financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets.

Cash flow characteristics test — The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

When an asset meets both of these conditions, it is required to be measured at FVTOCI unless, on initial recognition, it is designated at FVTPL to address an accounting mismatch.

For such assets, interest revenue, foreign exchange gains and losses, and impairment gains and losses are recognized in profit or loss with other gains or losses (i.e., the difference between those items and the total change in fair value) recognized in other comprehensive income (OCI). Any cumulative gain or loss recorded in OCI would be reclassified to profit and loss on derecognition or dealt with in accordance with specific guidance in the case of reclassifications.

Interest income and impairment gains and losses are recognized and measured in the same manner as assets measured at amortized cost such that the amounts in OCI represent the difference between the amortized cost value and fair value. This results in the same information in profit of loss as if the asset were measured at amortized cost, yet the statement of financial position reflects the instrument’s fair value.

Additional guidance

The final standard also adds guidance on how to determine whether financial assets are held under a business model that is "hold to collect" or "hold to collect and sell," and includes examples and explanations of the types and levels of sales that are acceptable for such business models.

In addition to guidance on the business model test, the standard adds guidance on the contractual cash flow characteristics test to clarify that in basic lending arrangements, the most significant elements of interest are consideration for the time value of money and credit risk. If the time-value-of-money element is modified (e.g., interest rate resets every month to a one-year rate), an entity is required to assess the modified element against new criteria introduced by the amendment.

The application guidance also introduces an additional exception that allows certain additional prepayment features to meet the contractual cash flow characteristics requirements to qualify for amortized cost or FVTOCI measurement.

Effective date

The standard has a mandatory effective date for annual periods beginning on or after January 1, 2018, with earlier application permitted (subject to local endorsement requirements). The standard is applied retrospectively with some exceptions (e.g., most of the hedge accounting requirements apply prospectively) but entities need not restate prior periods in relation to classification and measurement (including impairment).

The final version of IFRS 9 supersedes all previous versions of the standard. However, for annual periods beginning before January 1, 2018, an entity may elect to apply those earlier versions of IFRS 9 if the entity’s relevant date of initial application is before February 1, 2015.

At its July 18, 2014, inaugural meeting, the joint revenue transition resource group (TRG) and FASB and IASB board members discussed potential issues related to implementing the boards’ new revenue standard.

The purpose of the TRG is not to issue guidance but instead to seek feedback on potential issues related to implementing ASC 606 and IFRS 15. By analyzing and discussing potential implementation issues, the TRG will help the boards determine whether they need to take additional action, such as providing clarification or issuing other guidance. The TRG comprises financial statement preparers, auditors, and users from “a wide spectrum of industries, geographical locations, and public and private organizations.”

Topics discussed at the meeting included:

Determining whether an entity offering internet-related intangible goods and service arrangements is a principal or an agent.

Determining whether certain amounts billed to customers should be presented as revenue or a reduction of costs.

Sales-based and usage-based royalties in contracts with licenses and goods or services other than licenses.

The PCAOB and the Danish Business Authority (DBA) have entered into a cooperative agreement regarding the oversight of audit firms subject to the regulatory jurisdictions of both regulators.

The agreement, which is effective immediately, allows the exchange of confidential information of firms operating in both jurisdictions and is intended to enhance the regulators’ supervisory oversight, inspections, and investigations of the firms.

The two regulators also signed a data protection agreement to ensure that national data protection requirements are performed during any transfer of information.

Consolidation — Principal versus agent analysis

Not to align the definition of participating rights for voting interest entities with the definition of participating rights for variable interest entities.

Not to establish separate recognition, measurement, and disclosure consolidation requirements for nonpublic business entities as part of this project.

To require modified retrospective application (including a practicability exception) with an option for full retrospective application.

To make the final standard effective for public business entities for annual periods and interim periods within those annual periods beginning after December 15, 2015. The guidance would be effective for other entities for annual periods beginning after December 15, 2016, and interim periods beginning after December 15, 2017.

In addition, the FASB directed the staff to prepare an Accounting Standards Update, which will be reviewed by stakeholders.

For more information, see the related Deloitte Accounting Journalentry and the meeting minutes on the FASB’s Web site.

FASB ratification of EITF consensuses

The FASB approved the issuance of Accounting Standards Updates for the following consensuses reached at the June 12, 2014, EITF meeting:

Insurance — Disclosures about short-duration contracts

Not to include any reinsurance accounting issues within the scope of its insurance project.

To require insurance entities that issue short-duration insurance contracts to provide disaggregated incurred- and paid-loss development tables that disclose, at a minimum, activity from (1) the earliest period for which uncertainty arose about the amount and timing of claims payments through (2) the most recent year presented in the financial statements. However, the period for which the tabular information is disclosed need not exceed 10 years.

To require entities to disclose in annual financial statements information about (1) the methods and assumptions used in determining the liability for unpaid claims and claim adjustment expenses and (2) the reasons for any material changes in judgments used in the computation of the liability for unpaid claims and claim adjustment expenses (e.g., a change in assumptions).

To require insurance entities (other than health insurance entities) to disclose the percentage payout of claims by accident year.

For more information, see the related Deloitte Accounting Journalentry and the meeting minutes on the FASB’s Web site.

As part of its simplification initiative, the FASB has issued two proposed ASUs* intended to reduce the cost and complexity of financial reporting related to inventory measurement and extraordinary items.

One proposal would require entities to use the lower of cost and “net realizable value” instead of the lower of cost or “market” (as currently defined in ASC 330) when measuring inventory. This would eliminate the two conditions for “market” value in ASC 330 that require a reporting entity to consider the “replacement cost of inventory and the net realizable value of inventory, less an approximately normal profit margin.”

The other proposal would eliminate the concept of extraordinary items from U.S. GAAP. The FASB believes that eliminating this concept would save time and reduce costs for preparers as well as alleviate uncertainty in the evaluation of an unusual or infrequent item.

The proposed ASUs are expected to be effective for annual periods (including interim periods) beginning after December 15, 2015.

The FASB has published the latest issue of its quarterly e-newsletter, "FASB Outlook," which provides high-level information about the FASB’s projects and key activities.

This issue features:

Chairman Russ Golden’s discussion of the Board’s simplification initiative, the FASB’s key joint projects with the IASB, and progress the FASB and Private Company Council have made in developing alternative guidance for private companies.

Information on the FASB’s disclosure framework project.

What “investor roadshows” can teach the FASB about key accounting issues that affect investors.

At its meeting yesterday, the Private Company Council (PCC) discussed its proposal on identifiable intangible assets, which would give private companies the option of recognizing fewer intangible assets in a business combination.

The PCC made the following tentative decisions:

An entity that elects the option would not recognize intangible assets for noncompete agreements and would only recognize intangible assets for customer relationships if such assets can be sold or licensed independently from other assets of a business.

When elected, the option would be applied prospectively to all intangible assets arising from business combinations occurring after adoption (i.e., the option would not affect intangible assets recognized from previous business combinations).

An entity that elects the option would be required to amortize goodwill in accordance with the separate goodwill accounting alternative in ASU 2014-02. However, an entity could choose to amortize goodwill without electing the option.

Other topics discussed at this week’s meeting included:

Complexities related to private companies’ accounting for stock-based compensation and certain partnership transactions (e.g., formation); ultimately, the PCC directed the FASB staff to conduct pre-agenda research on both of these topics.

The PCC’s views on the FASB’s projects on impairment of financial instruments and pushdown accounting.

The PCC has scheduled its next meeting for September 16, 2014, at which time it will continue discussing the intangible asset alternative and decide whether the proposed ASU should be reexposed for comment.

For more information about the PCC’s July 15, 2014, meeting, see the media recap on the FASB’s Web site.

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